EOB Trainee Manual Consolidated V2 PDF

ELEMENTS OF BANKING 1 COURSE CONTENT 1. Overview of Banking Business 2. Functions of Banks 3. Banking Products and Classification 4. Income Sources and Financial Structure of Banks 5. Bank Regulatory Structure and Appraisal COURSE OBJECTIVES 1. Understand banks financial int...

ELEMENTS OF BANKING 1 COURSE CONTENT 1. Overview of Banking Business 2. Functions of Banks 3. Banking Products and Classification 4. Income Sources and Financial Structure of Banks 5. Bank Regulatory Structure and Appraisal COURSE OBJECTIVES 1. Understand banks financial intermediation role as a bridge between the deficit and surplus sector and as a critical factor in Economic developments 2. Understand the functions of banks as they relate to the services offered to customers and their monetary policy functions. 3. Understand the bank’s products, characteristics, deployment and how these dynamics provide solution to the financial needs of stakeholders. 4. Understand fund sourcing, utilization and profiting from operations. 5. Have a working knowledge of the structure of a bank’s financial statement and an understanding of the items contained therein 6. Understand the Regulatory Framework and Policies in place in the banking industry in Nigeria, and the criteria for appraisal of banks 2 MODULE 1: OVERVIEW OF BANKING BUSINESS A Bank is an institution that is licensed to carry out the business of Banking The banking Business is defined in the BOFIA (Nigeria Bank and Other Financial Institutions Act of 1991 (Amended 2020); Banking Business means the business of receiving deposits on current account, savings account or other similar account, paying or collecting cheques, drawn by or paid in by customers; provision of finance or such other business as the Governor may, by order publish in the Gazette and designate as banking business; Banks accept deposits and make loans and derive a profit from the difference in interest rates paid and charged, respectively. Banking is all about trust. The higher the degree of trust the Banking system can elicit, the greater its stability and hence, the healthier it is. The financial transactions that were brought together under the term banking had taken place previously in one form or another. Because of its central importance, it is useful to take a brief look at how banking came into existence. Deposit banking which includes the creation of money The Genesis of Banking The genesis of banking can be traced back to as early as 2000 BC in Babylon when a functional system of banking was established. Bankers and banks were given different names in different places. It is speculated that the word ‘bank’ must have been coined from Banco San Giorgio, which was established in Genoa in 1407. The Bank of Amsterdam, basically established in 1609 to cater for the banking needs of Amsterdam businessmen, was a pioneer of modern banking by its introduction of a certificate of deposit and receiving all forms of coins. The roles of Goldsmiths in Britain and the effect of the gold rush of 1848 in the United States were also significant in the evolution of modern banking. The History of Banking in Nigeria In the late nineteenth century, there were a lot of trading activities along the Nigerian coastal areas. Therefore, banking evolved to support these activities. In August 1891, the Chairman of Elder Dempster Company initiated the setting up of a branch of the African Banking Corporation. The purpose of this was to boost the British shipping business operated by the company. The bank was given the privilege of importing silver coins from Britain for use in Nigeria as from January 1892. 3 Elder Dempster Company took over the bank on payment of 1000 pounds sterling and the bank became incorporated on 1st March 1893 as the Bank of British West Africa (BBWA). The bank was biased in favour of the Elder Dempster Company, so there were a lot of agitations by British traders. This development led to the establishment of a second bank in 1899 known as Anglo African Bank, which later became the Bank of Nigeria. The BBWA was merged with the new bank (i.e. the Bank of Nigeria) in 1912. In 1917, another bank known as the Colonial Bank was set up. This bank, later became Barclays Bank Nigeria Limited (and is now known as the Union Bank (Nigeria) PLC). This bank posed a formidable competition for BBWA. In 1948, the British and French Bank was established. Later in 1961, it changed its name to United Bank for Africa Limited, now PLC. In fact, the First Bank, Union Bank and United Bank for Africa (UBA) are the three largest banks in Nigeria today, among the twenty-five banks comprising the Nigerian banking industry. During the period 1929 to 1952, a number of indigenous banks were established. The Agbonmagbe Bank Ltd. (now known as Wema Bank) was set up in 1938, followed by African Continental Bank (ACB), which was set up in 1948. During the period, February 1951 and May 1952, 18 indigenous banks were registered. All of them failed without any exception within a short period. The failure was attributed to lack of banking expertise and non-prudent lending policies. From independence in 1960 to 1985, there were a total of 40 banks in Nigeria, made up of 12 merchant banks and 28 commercial banks. Due to deregulation, however, the number of operating banks in the country increased phenomenally from 40 in 1985 to 66 in 1988, 100 in 1990 and 120 in 1992. Equally, the banks' branches increased from 1316 in 1985 to 1698 in 1988, 1944 in 1990 and 2027 in 1992. Thus, within a period of 7 years (1985 to 1992,) the Nigerian banking industry witnessed a growth that has not been recorded in the first 25 years of the country as an independent nation. However, by December 2002, there were a total of 90 licensed banks, 28 community banks, 74 primary mortgage institutions and 6 development banks. The 2004 banking sector reforms commenced with the announcement of a 13-point reform agenda by the CBN on July 6. A major element of the reform programme was the requirement for banks to achieve a minimum shareholders’ fund of N25 billion by the end of December 2005. Banks were specifically required to achieve this through fresh capital injection or through merger/acquisition arrangements with other banks. At the expiration of the deadline on 31st December 2005, twenty-five (25) banks emerged from seventy-five (75) banks out of the eighty-nine (89) banks that existed at the end of December 2004. Fourteen (14) banks, which had negative shareholders’ fund and, therefore, insolvent had their licenses revoked by the CBN. 4 Growth, Development and Performance of Banking Institutions in Nigeria Banks are germane to the economic development of a nation through the financial services they provide. They occupy a significant place in the economy of every nation as the prime movers of its economic life. The intermediation role of the banks is said to be a catalyst for the economic performance and growth. This function is of utmost importance to any economy that intends to be viable with respect to economic growth and development because it creates links between the surplus and the deficient units of an economy. The Nigerian banking sector over the past 20 to 25 years has experienced boom and bust in a cyclical pattern. After the implementation of the structural adjustment program in 1986 and the deregulation of the financial sector, new banks proliferated, mainly driven by attractive arbitrage opportunities in the foreign exchange market. Prior to the deregulated period, financial intermediation never took off and even declined in the 1980s and 1990s. The sector was highly oligopolistic with remarkable features of market concentration and leadership in terms of total assets, deposit liabilities and credits ranging from 45% to 50%. The sector was characterized by small-sized banks with high overheads; a low capital base averaging less than $10 million; heavy reliance on government patronage and loss-making. Nigeria's banking sector was characterized by a high degree of fragmentation and low levels of financial intermediation up until 2004. In light of the foregoing, banks are compelled by the Central Bank of Nigeria to raise their capital base from N2 billion to 25 billion on or before 31st December, 2005. Most banks resorted to mergers and acquisitions as survival strategy, which saw a reduction in the number of banks from 89 to 25. The financial performance of a few banks has been impressive, but most banks have performed below expectations leading to a number of corporate failure and distresses in the sector. Corporate distress and failure have persisted in the Nigerian banking industry since 1952, as a result of which the ability of the sector to serve as the hub for economic growth and development in the country has been significantly affected. Recent records have shown that from 1994 to 2006 alone, the regulatory authorities in Nigeria have withdrawn the operating licenses of fifty (50) banks in the country. Among this number were the 14 banks, which could not scale the hurdle of the 2005 consolidation exercise, because they had negative shareholders’ funds. Despite the 2005 banking sector consolidation, reports from the regulatory authorities have shown that there are still a number of problems that bedevil the 5 Nigerian banking industry and the number of marginal sound banks in the industry has doubled from 2006 to 2007. Empirical studies have also shown that, the corporate failure of banks in Nigeria has inflicted severe hardship on depositors, shareholders and other stakeholders in the country. Money creation Deposit banking evolved with the goldsmiths Goldsmiths usually had secure strong rooms. People had handed over to them their excess gold, silver and other valuables for safekeeping The goldsmiths were authorized to pay the bearer of a letter a certain amount from what they had on deposit. Privately- issued notes did begin to make their appearance as a medium of exchange Later, the goldsmiths realized that the deposits they tended remained at a constant level. So, they started to issue receipts over and above those they had already given out, both to pay for things themselves and increasingly, as loans at interest. This new paper was entirely fictitious and not backed-up by currency (gold or silver). This transaction called money creation, became an integral part of the new banking. 6 So now Because Adrian Deposited money in the bank Mrs Essien has money to loan to do her business So now total assets of banks have increased from 100,000 to 175k BEING assets in Adrian and drive-up bank and in addition Essien now has money to do biz If nobody Loans money from Drive up Bank it remains the same, If Mr Enejo approached Drive up bank for loan of N50,000 then the below happens 7  Drive Up Bank Liability ASSET Being Mrs Essien Money with the Reserve with CBN bank 75,000 (CRR) 7,500.00 Liquidity reserve 11,250.00 Cash 6,250.00 Loan To Mr enejo 50,000.00 Total 75,000 75,000.00 If Mr enejo has an account with Adrian Bank and he deposits his loan proceeds there, the below will happen Adrian Bank Book Liability ASSET Being Mr benson Money with Reserve with CBN bank 100,000 (CRR) 15,000.00 Being Enejo's money with the bank 50,000.00 Liquidity reserve 22,500.00 Loan to Mrs Essien 75,000.00 Cash 37,500.00 Total 150,000 150,000.00 8  Roles of Banks in the Economy Banks have important roles to play in an economy, as they are intermediaries between units with shortages and surpluses of capital. The products they offer include savings, lending, investment, mediation and advice, payments, ownership, guarantee and indemnities. As a financial intermediary between market players, and performs the important functions: i. Banks act as assessors of risk. As a rule, banks are better equipped to value the risks of various investments than individual investors who have surpluses available. Also, through their larger scale, banks are more able to spread risks. ii. Ensure price stability and facilitate rapid economic development. iii. Mobilization of savings for investment. iv. Create new demand deposits in the process of granting loans and purchasing investment securities. v. Facilitate trade both inside and outside the country through accepting and discounting bills of exchange. vi. Increase the mobility of capital. vii. Support capital formation, control speculation and maintain a balance between requirements and availabilities of funds. viii. Direct financial resources into desired channels. ix. Financing of industry and other employment-generating activities x. Financing of consumer activities. xi. Financing of trade and agriculture. xii. Brings about financial stability through efficient and effective operations. xiii. Extends credit to the public for productive activities and accelerates the pace of a nation’s economic growth and its long-term sustainability. xiv. Channels funds to various economic agents that need them for economic uses. xv. It creates links between the surplus and the deficient units of an economy. xvi. Contributes to market capitalization of the stock exchanges thereby ensuring smooth and stable income provision to money and capital market players. xvii. Enhances national savings and investment. xviii. Increases the volume of goods and services produced in an economy over time through the multiplier effect. xix. Provide stable and smooth income to attract potential investors. 9  Current Issues in the Nigerian Banking Sector Financial Inclusion SANNEF (Shared Agent Network Expansion Facilities) initiative for Financial Inclusion, aggressive rollout of 500,000-agent networks to offer basic financial services, such as Cash-in, Cash-out, funds transfer, etc. Payment Service Banks e.g. Momo Emergence and support of Financial Technology institutions (fin tech). These are Companies that utilize apps, software or technology that allow people or businesses to digitally access, manage or gain insight into their finances or make financial transactions Recapitalization: On the 28th of March 2024 the CBN came up with a circular mandating the increase of minimum capital for all Banks within a period of 24 months commencing from April 1 2024 and terminating on March 31, 2026. Foreign Exchange: In 2023 the CBN embarked on a process to harmonize the exchange rate by allowing the forces of demand and supply to determine the rate of exchange between naira and the dollar with the hope that the parallel and official rates would converge. Current Issues in the Nigerian Banking Sector – Capital Requirement Type of Bank Authorization Minimum Capital Current Minimum Capital Future Commercial International N50B N500B National N25B N200B Regional N10B N50B Merchant National N15B N50B Non - Interest National N10B N20B Regional N5B N10B 10  How Banks carry out Financial Intermediation in the Economy The principal business of banks, particularly commercial banks, is to make loans to qualified borrowers. This is done in three ways viz: Direct Lending, Guarantee or Underwriting Attributes Direct Lending Underwriting Guarantee When the bank channels When the bank makes it When the bank funds to deficit sectors of easier for its customers to find provides an the economy through credit from some source with assurance Definition direct loans the bank agreeing to (guarantee) to a underwrite the customer’s third party lender security issue on behalf of its customer Primary Obligation Secondary Obligation Secondary Obligation Obligation Overdraft, Term Loans, Commercial paper. Banker’s Advance Import Finance Facility, acceptance payment Examples Trade Finance etc guarantee, performance bonds etc High Medium High Risk All of Credit Risk All of Credit Risk All of Credit Risk Interest Spread. Interest Spread Fees Return High Credit related fees Brokerage Fees 11 Different Players in the Banking Sector Differences Between Merchant and Commercial Banks Merchant Banks Commercial Banks Can Underwrite Equity and Cannot Underwrite Debt Issues issues Minimum deposit of N100m No minimum deposit (or as prescribed by CBN) Accepts Deposits Cannot accepts Deposits withdrawable by cheques withdrawable by cheques. Can grant retail and Cannot grant retail loan of Corporate Loans any kind. Cannot participate in Can participate in Capital Capital Market Activities Market activities 12 Similarities Between Merchant and Commercial Banks Both accept deposits from the general Public Both can provide Both provide treasury foreign Management exchange Services services Both give out loans and facilities Both cannot provide Insurance underwriting, loss adjusting services 13 MODULE 2: KEY FUNCTIONS OF BANKS Banks play several key functions in an economy, and we can explain them using the analogy of a financial hub or a bridge that connects various parts of an economy. Imagine a bustling town divided by a river, with businesses, individuals, and government agencies on both sides. Banks are like sturdy bridges that connect these two sides, enabling economic activities to flow smoothly. Here are the key functions of banks, illustrated with examples: Providing a Safe Place for Money (Depository Services) and Lending Money (Credit Services) – Financial Intermediation Banks offer a safe place for people and businesses to keep their money. It's like a secure vault under the bridge where your money is protected. Example: When you deposit your salary into a bank account, the bank ensures it's kept safe until you need it. Now Banks take these monies deposited and Banks lend them to individuals and businesses, supporting investments and purchases. Think of this as the bridge loaning you a bicycle to cross, even if you don't have one. Example: When you take out a mortgage to buy a house, the bank provides the funds, allowing you to become a homeowner. Banks also invest in infrastructure projects, such as building roads, bridges, and factories, which stimulates economic growth. This is like the town being expanded to accommodate more traffic and business. Example: A bank might provide financing for a new manufacturing plant, creating jobs and boosting local production. This process of accepting deposits and using those deposits to lend thereby creating loans and making investments is also called financial intermediation. Transactional Services (Pay and Receive Money on behalf of Customers) Transactional services are one of the core functions of banks, and they involve various activities related to handling your money. Think of transactional services as the tools and services that allow you to manage your finances, make payments, and keep your money safe. Here's a simple explanation with examples and illustrations: 1. Deposits: What it is: Depositing money into your bank account. Example: You receive your salary and deposit it into your bank account. 2. Withdrawals: 14  What it is: Taking money out of your bank account. Example: You withdraw cash from an ATM to buy groceries. 3. Payments: What it is: Transferring money to pay for goods and services. Example: Using your bank's mobile app to pay your monthly utility bills. 4. Cheques: What it is: A written order to your bank to pay someone from your account. Example: Writing a cheque to your landlord for rent. 5. ATM Services: What it is: Using ATMs to withdraw cash, check your balance, or deposit money. Example: Getting cash from an ATM machine at a convenience store. 6. Online and Mobile Banking: What it is: Accessing your bank account and making transactions through a website or mobile app. Example: Checking your account balance on your smartphone. 7. Credit and Debit Cards: What it is: Plastic cards linked to your bank account for making purchases or getting credit. Example: Using your credit card to buy a new laptop. These transactional services are like the tools in your financial toolbox. Banks provide these services to make it easy and safe for you to manage your money and make payments. Whether you're depositing a cheque, paying bills online, or using your debit card to shop, banks play a crucial role in facilitating these transactions securely and efficiently. Facilitating Savings and Investments (Savings and Investment Management Services) Banks offer savings accounts, certificates of deposit, and investment opportunities to help people grow their wealth. It's like providing ramps on the bridge to reach higher ground. Example: When you invest in a mutual fund through your bank, your money has the potential to grow over time. 15 With regard to the above Banks offer investment management services to help you nurture and grow your wealth, just like a gardener tends to your garden to make it flourish. They take into account your goals, handle the day-to-day care of your investments, and provide guidance to ensure your financial garden thrives over time. - Currency Exchange (Foreign Exchange Services) Banks allow for currency exchange, helping businesses and travelers trade one currency for another. This is akin to a bridge allowing people from different towns to meet in the middle. Example: When you exchange your local currency for dollars before a trip to Europe or the US, the bank provides the foreign currency you need. Banking as the Bridge in International Trade (Trade Services) Imagine you are a toy seller in your town. However, you don’t make the toys and have to buy them from a toy maker in China. This means you have to import the toys. But you do not have a personal relationship with the toy maker, so they will not send the toys to you unless they have some guarantee of payment. This is where Banks step in to make international trade possible using two popular payment methods: 1. Letter of Credit (Payment Assurance) Your Bank issues a Letter of Credit on your behalf as a buyer or importer, a magical document that promises to pay the toy maker (the seller or the exporter) upon transferring title documents of the toys to the buyer through the Bank. It's like having a guarantee that the seller will get paid once the toys are delivered. Example: The seller is assured that once they transfer title or ownership of the toys to the buyer, they will receive payment, thus eliminating the risk of not getting paid 2. Bills for Collection Now imagine you have been dealing with the toy maker for some time now and have now established some sort of relationship. However, the toy maker still expects some guarantee of payment. In this regard they could send you the title documents to the toys through their own Bank to your Bank, however, with the instruction that these documents be not released to you until your account is funded so you can make payment to them. Thus, your Bank acts purely as a collection intermediary (an agent), keeping documents from you (the buyer) until payment or acceptance of a draft. In this scenario your Bank does not provide a guarantee of payment to the seller and neither can she enforce collection from you. 16 Monetary Policy Implementation Banks act as the Traffic Controllers of Monetary Policy. Imagine a bustling city with lots of vehicles on the road, and there's a need to manage traffic effectively to ensure a smooth flow. Banks play a role similar to traffic controllers when it comes to implementing monetary policy. Think of the whole process this way: 1. The Central Bank as the Traffic Headquarters (Monetary Authority) Think of the central bank as the traffic headquarters, responsible for overseeing the entire traffic system. They want to ensure there's just the right amount of traffic on the road (money supply) to keep the city moving smoothly without causing congestion (inflation) or gridlock (recession). 2. Banks as Traffic Lights (Financial Intermediaries) Now, picture banks as traffic lights at various intersections across the city. They have control over the flow of vehicles (money) at their respective locations. When the central bank wants to influence traffic, they communicate with these traffic lights (banks). 3. Interest Rates as Traffic Signals (Monetary Policy Tools) Interest rates are like traffic signals controlled by the banks. When the central bank wants to regulate the flow of money in the economy, they adjust these interest rates, just as traffic lights change from green to red. Lowering Interest Rates (Green Light): When the central bank wants to encourage spending and economic activity, they lower interest rates. It's like changing traffic lights to green, allowing more vehicles (money) to flow through the intersection. Raising Interest Rates (Red Light): If the central bank wants to slow down the economy and curb inflation, they raise interest rates. It's like changing traffic lights to red, signaling vehicles (money) to stop or slow down. 4. Bank Lending as Traffic Flow (Credit Availability) Banks play a crucial role in regulating the flow of money (traffic). When interest rates are low (green light), banks are more willing to lend money to individuals and businesses, encouraging economic activity. When interest rates are high (red light), banks may reduce lending, putting the brakes on economic activity. Example: If the central bank lowers interest rates, banks might offer lower mortgage rates, encouraging more people to buy homes and stimulating the housing market. 5. Bank Reserves as Fuel Tanks (Reserve Requirements) 17 Banks are required to keep a certain amount of money (reserves) in their vaults, much like vehicles need fuel to move. The central bank can adjust these reserve requirements to control how much "fuel" banks have to lend or invest. Example: If the central bank lowers reserve requirements, it's like allowing vehicles to carry more fuel, encouraging banks to lend more money. In this analogy, banks act as traffic lights, regulating the flow of money in response to signals (interest rates) from the central bank (traffic headquarters). Together, they help maintain a balanced and efficient traffic system (monetary policy) in the city (economy), ensuring that it runs smoothly without excessive congestion or gridlock. 18 MODULE 3: BANKING PRODUCTS AND CLASSIFICATION Bank Products can be classified in four different ways: 1. By their ownership ✓ Asset ✓ Liability products 2. By their effect on the balance sheet ✓ On Balance Sheet Products ✓ Off Balance Sheet Products 3. By their tenor ✓ Short-term ✓ Long-term products 4. By their source ✓ Intermediation Products ✓ Service Products 1. By Ownership Are the products owned by the Bank (assets) or they are owned by customers via deposits (Liability) - Assets Products ✓ Treasury Investments ✓ Inter-bank Placements ✓ Loans and Advances ✓ Cheque/Draft purchase ✓ Drawn Against Uncleared Effects (DAUE) ✓ Bankers Acceptances ✓ Commercial Papers ✓ Leases 19 - Liability Products ✓ Demand Deposits ✓ Savings Accounts ✓ Domiciliary Accounts ✓ Call Deposit ✓ Time and Term Deposit ✓ Inter-bank Takings ✓ Certificate of Deposits 2. On Balance sheet vs off Balance sheet (Effect on balance sheet) Do these products impact the balance sheet or not? - On Balance sheet Products ✓ Asset products ✓ Liability Products - Off Balance sheet Products ✓ Letter of Credit ✓ Guarantees ✓ Performance bonds ✓ Acceptances 3. Short Term vs Long Term (By tenor) The time it takes for the Products to mature - Short term ✓ Time Loan ✓ Call Deposit ✓ Demand and Savings deposit ✓ Commercial Paper ✓ Inter-bank Takings 20 ✓ Certificate of Deposits - Long term ✓ Term Loan ✓ Bonds ✓ Mortgages 4. By Source The units and departments that use the products Consumer Banking Products ✓ Savings Account ✓ Automated Teller Machines ✓ Card Products ✓ Leasing – Vehicles, Electronics etc. Transaction Products & Services ✓ Collection Services ✓ Customs Collection ✓ Tax collection [FIRS & IRS] ✓ Rates Collection Funds Transfer Products ✓ Standing Orders & Disbursements ✓ NEFT ✓ Nigeria Interbank Transfer Corporate Finance ✓ Financial Advisory Services 21 ✓ Mergers & Acquisition ✓ Capital Market Activities ✓ Debt Restructuring International Banking Services ✓ Money Transfer – WUMT, Moneygram ✓ Correspondent Banking ✓ LC’s & Bills for Collection Digital Banking Also known as Internet Banking, Virtual Banking E-banking, Online banking et al, It simply means the transfer of traditional banking services from the banking hall to the internet that can be used via Laptops, Pads, Smartphones. So instead of physically going to bank, clients can access and make use of these services from the convenience of their Systems. However, some people make a distinction between Online Banking and Mobile Banking. Where mobile banking is referred to banking services accessed and transacted via your mobile devices and smartphones The primary difference between mobile banking and internet banking is that mobile banking is accessed through an application on the smartphone, whereas internet banking is accessed through a browse, typically on a computer.... It typically requires one to download the mobile banking application from the respective Digital Banking Services ✓ Checking of account balances ✓ Payment for goods and services ✓ Bill payments ✓ Fund Transfers ✓ Standing instruction ✓ Cheque confirmation ✓ Cheque requisition 22 Digital Applications A broad term refers to any application software that can be used by a computer, mobile device, or tablet to perform useful tasks. A specific piece of such software is called a software application, application program, application or app Access More AccessMore is a new mobile payment application built on cutting- edge technology, offering tailored and personalized services, and excellent customer experience. Services on this App includes Instant transfers, account balance, Bills payments, Link BVN, Generate statements, Book deposits, et al Quick Bucks QuickBucks is a Mobile Banking Application for digital loans. It is a holistic platform for all loan products aimed at improving your borrowing experience – for retail Loans, Credit Card, Debit Card, Consumer Durable Loans and Device Financing Loan requests. The loans that can be accessed on Quickbucks include: ▪ Payday Loan ▪ Salary Advance ▪ Small Ticket Personal Loan ▪ Device Financing Mobile Banking – Premium What you can do on your Access Mobile Premium ✓ Carry out transactions in higher volumes to the tune of N2million daily ✓ Confirm Beneficiary name for Funds Transfers ✓ Purchase your Airline ticket ✓ Carry out your Cheque Management - Request, Confirmation and other cheque instructions ✓ Locate branch and ATMs closest to you ✓ Airtime top-up to any mobile network ✓ Transfer funds within Access Bank and to other Banks ✓ Pay bills - DSTV, PHCN, LCC. e.t.c ✓ Funds Transfer to Third Parties in Access Bank 23 ✓ Funds Transfer to accounts in other banks ✓ International Funds Transfer to any country 24 MODULE 4 – INCOME SOURCES AND FINANCIAL STRUCTURE OF BANKS 4.1. How banks make money: Banks make money through a series of activities; however, their main source of income is through financial intermediation. Banks accept deposits from the customers and compensate them by paying credit interest. In turn, the bank lend these monies to borrowers and charge them higher interest rates. The differential income is what then accrues to banks as income. Banks also earn income through other banks activities such as investment banking and wealth management services. 4.2. Liquidity versus Profitability: Liquidity and profitability are 2 of the key financial indices for banks. Liquidity refers to the ability of a bank to meet its short-term obligations, while profitability refers to the ability of a bank to generate profits. A bank with high liquidity can meet its obligations even if there is a sudden withdrawal of deposits or a decline in the value of its assets. This is critical as it ensures that the bank can continue to operate and provide financial services to its customers. A bank with high profitability will be able to generate a high return on its assets and equity. This means that the bank is making more money than it is spending, and so is to both retain profits as well as distribute profits to its shareholders. The ideal situation for a bank is to have both high liquidity and high profitability. However, these two goals usually conflict with each other. For example, a bank that holds a lot of liquid assets, such as cash and government bonds, will have a high liquidity ratio but a low profitability ratio. This is because liquid assets typically have low yields. Conversely, a bank that invests in illiquid assets, such as loans to businesses, may have a high profitability ratio but a low liquidity ratio. This is because illiquid assets can be difficult to sell quickly, so the bank may not be able to meet its obligations if there is a sudden withdrawal of deposits. 25  The ideal manner for a bank to balance its liquidity and profitability depends on its specific circumstances. Some banks may need to focus on liquidity in order to maintain the confidence of its depositors. Others may be able to take on more risk in order to generate higher profits. Ultimately, the goal of any bank is to be both liquid and profitable. 4.3. Banks sources of income: The main sources of income for banks are: i. Interest income: This is income made from the spread between the interest rate paid by borrowers and that paid to depositors. This means that, the higher the spread, the higher the interest income generated by the bank and vice versa. ii. Fee based income: this is income earned from non lending activities carried out by banks. Examples are card issuance fees, ATM withdrawal fees, overdraft fees etc. iii. Investment income: this is income from investing and trading in securities, such as stocks and bonds as well as derivatives iv. Foreign Exchange income: this is income from foreign exchange transactions. v. Other income: rental income, profit from sale of property etc. 26 4.4. Typical Structure of a Bank’s Income Statement N’ bn Interest income ** (interest expense) (**) Net interest income *** (Impairment charge) (**) Net interest income after impairment charge *** Commission and fees ** Net earnings *** (operating expense) (**) Profit before tax *** (tax) (**) Profit after tax **** Appropriations 27  4.5. Overview of Income Lines Income Line Source Drivers Interest income Loans and advances placements (Risk Assets) Interest rate Investment (T. Bills, bonds) Value of loans Placements/investments Commissions Foreign funds transfer service Volume of transactions Letters of credit commission Value of transaction Bills for collection commission Activity on current account Sale of FX Account maintenance fee Fees Management fee Value and volume of credit facilities / related Processing fee transaction Commitment fee Others Profit on sale of fixed assets Disposal of fixed assets Profit on disposal of shares Partial or full divestment Dividend 28  4.6. Overview of Expense Line Expense Line Source Drivers Interest Expense Deposit accounts (demand, time, savings, Interest rate domiciliary) Mix of deposit accounts Loan loss expense Loans and advances Volume of non- performing Other account receivables assets Other assets (due from Fls) Early problem Investment recognition Operating expenses Staff costs Number and quality of staff Premium on insurance of deposit Liabilities Value and age of Depreciation assets Admin & marketing expenses Efficiency in Utilities & communication cost administration & marketing Others Loss on disposal of assets Disposal of fixed assets Loss on disposal shares Partial or full divestment 29 4.7. Sample of Access Bank’s Income Statement 4.8: Typical Structure of Bank’s Statement of Financial Position 30 4.9 Structure of a Bank’s Statement of Financial Position - Cash Reserve: o Currently pegged at 45% and 10% of total deposits for commercial and merchant banks respectively. o The CBN is the custodian of these funds o It is not interest bearing and cannot be assessed by banks except under external circumstances o It is a monetary policy tool for reducing excess liquidity in the banking system. Notes, Coins and Balance with CBN and other banks: o Cash balances, notes and coin held as deposits with the Central Bank and other banks o Risk of loss is minimal - Risk Assets: o These are the core banking assets o They are a bank’s major source of income and have the risk of default can be high o Examples are overdrafts, loans, leases and mortgages - Minimum Risk Assets: o They are short term earning assets such as Treasury Bills, Interbank placements and CBN certificates o They are also liquid in nature o They earn the least income and also carry the least credit risk - Non-Banking Assets: o These are assets used in supporting the business o They do not earn interest directly o Examples are fixed assets and intangible assets such as banking software - Inter-Bank Borrowings: o Borrowings from discount houses and other financial institutions o Easily vanishes in the face of liquidity pressure o Pricing is determined by market dynamics - In Transit Funds and Accounts Payable: 31 o Collections that pass through the bank but are yet to be disbursed o They attract no interest expense o Examples are tax payable to government, revenue collected on behalf of third parties and draft outstanding - Deposits o Core source of funding for any bank o Major component of a bank’s expense line o The interest expense is a function of its deposit mix. o The cheaper the source of funds; the lower the expense and vis versa. o Examples are current, savings or fixed deposits. - Tier 1 Capital o It is a bank’s core capital o Consists of shareholders’ equity and retained earnings o Tier 1 capital is intended to measure a bank’s financial health and is used when a bank must absorb losses without ceasing business operations. o It easily vanishes in the event of illiquidity - Tier 2 Capital o This is a bank's supplementary capital o This is because it is less reliable than tier 1 capital o It includes revaluation reserves, hybrid capital instruments and subordinated term debt, general loan-loss reserves, and undisclosed reserves. 32 5.0. BANK REGULATORY STRUCTURE AND APPRAISAL Why Banks are Subject to Severe Regulations? ✓ Generally, because banks are systemically important ✓ To protect depositors, particularly small savers ✓ Maintenance of stability of the Nigerian financial system ✓ Preventing Fraud and Money Laundering ✓ Consumer (customer) Protection ✓ Ensure Capital Adequacy ✓ Ensure that banks are Liquidity in order to meet daily transactional requirements ✓ Ensure sound lending practices ✓ Ensure that banks do not engage in activities that can neutralise Monetary Policy objectives ✓ Market Integrity and ensure international competitiveness of local banks 5.1. Purpose of Banking Regulation and Supervision 1 Protect depositors and other stakeholders by reducing risk takings or ensuring appropriate mitigation for risks taken. 2 Promote the usual confidentiality and secrecy in banking operations. 3 To pursue government economic objectives through channeling funds to certain sectors of the economy. 4 Discourage the use of bank channels and facilities to support criminal or money laundering activities. 5 Set up machinery for early identification and resolution of failing or distressed financial institutions. 6 Proper monitoring of systematically important institutions to avert system risk or failure of several institutions at the same time. 7 Provide avenue for collaboration with the Regulators in other sectors of the Nigerian economy, like Insurance and Pension and even with foreign regulators. 5.2. Banking Regulatory Policies in Nigeria The key regulations that govern the activities of banks in Nigeria are as follows: Bank and Other Financial Institutions Act of 1991: This is the primary law guiding the activities of Banks in Nigeria. It deals with the requirement of establishment of banks, the duties of a bank, the powers of the CBN governor, etc. 33  Central Bank of Nigeria Act of 2007: This law and the BOFIA Act conferred on the Central Bank of Nigeria a measure of instrument autonomy for the effective discharge of its core mandate Prudential Guidelines of May 2010: Prudential Guidelines aim to address various aspects of banks’ operations, such as risk management, corporate governance, KYC and anti-money laundering/counter financing of terrorism and loan loss provisioning Money Laundering Act of 2004: makes comprehensive provisions to prohibit the laundering of the proceeds of a crime or an illegal act From time to time the regulators release circulars to augment the above laws 5.3. Regulators in the Nigerian Banking Industry Like everywhere in the world, the Banking Industry in Nigeria is highly regulated This degree of regulation is necessary to ensure that banks play their role in the economy with the highest degree of integrity and corporate governance The major organizations charged with regulating the banking industry in Nigeria are as follows: The Central Bank of Nigeria (CBN): The CBN is the apex regulatory authority of the financial system. The bank promotes monetary stability and a sound financial system Nigeria Deposit Insurance Corporation (NDIC): The NDIC compliments the regulatory and supervisory role of the CBN by insuring customer deposits Securities and Exchange Commission (SEC): The Securities and Exchange Commission, is the apex regulator of the Nigerian capital market 5.4. The Central Bank of Nigeria The functions of a Central Bank are as follows: Implementing monetary policies Controlling the nation’s entire money supply The Government’s banker and the banker’s banker (“lender of last resort”) Managing the country’s foreign exchange and gold reserves and the Government’s stock register Regulating and supervising the banking industry Setting the official interest rate – used to manage both inflation and the country’s exchange rate – and ensuring that this rate takes effect via a variety of policy mechanisms 34  Nigeria Deposit Insurance Corporation Functions - Insuring all deposit liabilities of licensed banks - Giving assistance to insured institutions in the interest of depositors, in case of imminent or actual financial difficulties - Guaranteeing payments to depositors, in case of imminent or actual suspension of payments by insured institutions up to the maximum as provided for in section 20 of this Act; - Assisting monetary authorities in the formulation and implementation of policies so as to ensure sound banking practice and fair competition among insured institutions in the country; - Pursuing any other measures necessary to achieve the functions of the Corporation provided such measures and actions are not repugnant to the objects of the Corporation CBN REGULATORY FRAMEWORK MINIMUM CAPITAL MARKET INTERVENTION SUPERVISION REGULATORY GUIDELINES Commercial Banks International – N500B Monetary Policy Rate Regular Returns Prudential Guidelines National – N200B Currently: 27.50% (+500/-100 Regional – N50B basis points (1 basis point =.01% HOLDCO Specialised Banks Microfinance Bank OMO – Tbills Intervention Examination NUBAN Non-interest Bank: -Regional (N10B) -National (N20B) Primary Mortgage Rates CRR – Cash Reserve Special Investigation Cashless Policy Institutions (N5B) Ratio 50.% Safer & Easier Trnx LR – Liquidity Ratio Increases Trnx Velo. Others 30% Reduces Prnt Cost Merchant Banks: N50B - National Guaranteed Credit Moral Suasion Capital Adequacy Development Institutions Control Of Bank Credit Single Obligor Finance Companies Others Etc Single Obligor Limit (SOL) The total outstanding exposure by a bank to any single person or a group of related borrowers shall not at any point in time exceed 20% of the bank’ shareholders fund unimpaired by losses 331/3% of a bank’s off-balance sheet engagements shall be applied in determining the bank’s statutory limit to a single obligor as per above FOR EXAMPLE: 35 Suppose a Bank has100m shareholders funds out of which 20m was set aside for loan loss provisioning The shareholders’ funds unimpaired by losses would be 80m (100 – 20) Therefore, the single obligor limit would be 16m (20% of 80m) If the Bank lends Dangote 14m and Dangote requests for additional funding, the Bank can give Dangote additional funds of up to N6mm as a BA because in computing the SOL only 33.3% of 6,000,000 would be taken into Account) 5.6. Prudential Guidelines on Loan Loss Provisioning 5.6.1. Background to the Introduction of prudential Guidelines Lack of standardization of reports Profitability from Non-Performing Loans Profitability without liquidity International Comparison of results 5.6.2. Objectives of Prudential Guidelines To facilitate timely recognition of deterioration of assets quality. To facilitate classification of credit exposures based on perceived risk To facilitate comparability in the industry To harmonize provisioning for assets 5.6.3. Scope of Prudential Guidelines Credit portfolio Other assets Off balance sheet engagements 5.6.4. Objective Criteria of Prudential Guidelines PERFORMING CREDIT: A credit is deemed to be performing if payment of both principal and interest are up to date and are in accordance with the agreed terms NON-PERFORMING CREDIT: 36 A credit is deemed non-performing when any of the following conditions exist: Interest or principal is due and unpaid for a period of 90 days or more Interest payment equal to 90 days interest or more have been capitalized, rescheduled, or rolled over into a new loan CLASSIFICATION OF NON-PERFORMING CREDIT Substandard (overdue>90days); ii. Doubtful (180-360days); and iii. Lost (>360days). 5.6.5. Provision for Non-Performing Facilities Provision made for identified and assessed Credit facilities based on the extent of deterioration of the credits Provision made on the basis of perceived risk of default on specific credit facilities Provision made in recognition of the fact that Performing credits even harbor some risk of losses no matter how small. Amounts already due for payment - Interest overdue for > 90 days should be suspended and recognized on Cash Basis only - Principal repayments that are overdue for more than 90 days should be fully provided for and recognized on cash basis only. SPECIFIC PROVISION Sub-Standard Credit Facilities o 10% of outstanding balance Doubtful Credit Facilities o 50% of the outstanding balance Lost Credit Facilities 100% of outstanding balance GENERAL PROVISION 37  General provisions as 2% of net assets less the portion that has been provided for specifically EFFECTS OF PROVISIONS Provisions reduce the value of assets and ensures that they are stated at net realizable value Provisions, since they are made against profit and loss account, reduce profit, and ensures that earned interest income is real. Affects the rating of a bank since they reflect bank’s asset management capability 5.7. Prudential Analysis (CAMELS Parameter) and Regulation 5.7.1. Capital Adequacy The extent to which a bank’s capital can sufficiently carry the risk weighted assets both on and off its balance sheet The assets on and off a bank’s balance sheet have standard risk weighting attached to them The summation of these weighting gives the total Risk Weighted Assets of the bank This is compared with the core capital and the total capital of the bank to determine the adequacy of the Capital Nigeria operates a stratified CAR with a base rate of 10% for National Banks & 15% for International Banks and D-SIBs, higher than the Basel III minimum The higher the percentage the better for the bank 5.7.2. Asset Quality Banks loan assets are the main source of income. Their quality is therefore fundamental in determining the health of the bank Asset quality refers to the extent to which the assets of the bank are performing. An ideal situation is to have substantial portion of the assets as performing, this will imply good performance and ability to further invest in growth A reverse is bad news for banks, and it is the surest way to distress The evaluation of asset quality should include, but is not limited to, a review of: 38  o the level, distribution, and severity of classified assets, o the adequacy of internal controls, o credit standards and practices, and o the quality of loan documentation. 5.7.3. Management Quality Management must be made up of experienced and sound individuals with the overall interest of the organization at heart. Evaluation of management quality includes: Technical competence, leadership, and administrative ability. Strong Corporate Governance Compliance with relevant banking regulations and statutes. Effectiveness of internal controls, management information systems and the strength and integrity of the internal and external audit programs. Management depth and succession planning. Transparency and Full disclosure 5.7.4. Earnings Capacity It derives from assets quality and measures overall sustainability of earnings The evaluation of earnings should include, but is not limited to, a review of: Quality and prospects for core income. The ability to cover losses and maintain adequate capital including compliance with the minimum earnings standard. The composition of earnings and sustainability of the various earnings components. Peer group comparisons. Compliance with laws and regulations relating to earnings and dividends. 5.7.5. Liquidity This is ability to meet demand at all times including: Withdrawals by customers Commitments on contractual obligations 39  Funds for day-to-day operations Precautionary funds for unplanned withdrawal Liquidity is affected by Quality of assets Quality of earnings Earnings retention Assets/Liability Management Effects of poor liquidity Sourcing funds at very high rate Reduced profitability or increased losses Run on the bank Eventual collapse of the institution Ripple effects on the economy and investors’ confidence CBN liquidity measures include: Cash Reserve Requirement Liquidity Ratio Statutory Reserve Loan to Deposit Ratio 5.7.6. Sensitivity to Market Risk Degree to which Bank Capital is affected by market volatility i.e., Changes in interest rates Changes in exchange rate Changes in equity prices Changes in prices of commodities Sensitivity to Market is affected by Volume and diversification of deposits Availability of interbank deposits 40  Terms and cost of Central Bank refinancing Earnings retention Assets/liability Management Effects of High Sensitivity to Market Risk Volatile profitability Increased funding cost Vulnerability to takeover/collapse Sensitivity to Market Risk measures include: Gap i. e RSA – RSL % of wholesale deposit/total deposit Interest Rate Risk (IRR) 5.8. Typical Banks Rating 5.8.1. Use of Rating It helps the depositor / investor ascertain the suitability and capability of a bank Depositors, Correspondent Banks, Fund managers are able to easily satisfy restrictions on types of involvement that they can have with a bank A rating enables the investors to appreciate the risk profile of the bank. A rating improves or defines the overall financial standing of a bank Eligibility for listing on some exchanges or disclosure requirements sometime depend on rating of the bank concerned. 5.8.2. Objectives Counterparties & net depositors understand risks better Helps the regulatory authorities to build a sound financial system Providing the financial markets with information for pricing, exposure capability and management ability Ratings could be: 41  Solicited Based on a letter of engagement Short term in focus Focused on local [Naira] obligation only 42 43